FINANCIAL REPORTING AND ANALYSIS CASES.doc

Chapter 6Reporting and Interpreting Sales Revenue, Receivables, and Cash

ANSWERS TO QUESTIONS

1. The difference between sales revenue and net sales is the amount of goods returned by customers because the goods were either unsatisfactory or not desired and also includes sales allowances given to customers (also refer to the answers given below to questions 3, 4 and 5).

2. Gross profit or gross margin on sales is the difference between net sales and cost of goods sold. It represents the average gross markup realized on the goods sold during the period. The gross margin ratio is computed by dividing the amount of gross margin by the amount of net sales. For example, assuming sales of $100,000, and cost of goods sold of $60,000, the gross margin on sales would be $40,000. The gross margin ratio would be $40,000/$100,000 =.40. This ratio may be interpreted to mean that out of each $100 of sales, $40 was realized above the amount expended to purchase the goods that were sold.

3. A credit card discount is the fee charged by the credit card company for services. When a company deposits its credit card receipts in the bank, it only receives credit for the sales amount less the discount. The credit card discount account either decreases net sales (it is a contra revenue) or increases selling expense.

4. A sales discount is a discount given to customers for payment of accounts within a specified short period of time. Sales discounts arise only when goods are sold on credit and the seller extends credit terms that provide for a cash discount. For example, the credit terms may be 1/10, n/30. These terms mean that if the customer pays within 10 days, 1% can be deducted from the invoice price of the goods. Alternatively, if payment is not made within the 10-day period, no discount is permitted and the total invoice amount is due within 30 days from the purchase, after which the debt is past due. To illustrate, assume a $1,000 sale with these terms. If the customer paid within 10 days, $990 would have been paid. Thus, a sales discount of $10 was granted for early payment.

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5. A sales allowance is an amount allowed to a customer for unsatisfactory merchandise or for an overcharge in the sales price. A sales allowance reduces the amount the customer must pay, or if already paid, a cash refund is required. Sales allowances may occur whether the sale was for cash or credit. In contrast, a sales discount is a cash discount given to a customer who has bought on credit, with payment made within the specified period of time. (Refer to explanation of sales discount in Question 4, above.)

6. An account receivable is an amount owed to the business on open account by a trade customer for merchandise or services purchased. In contrast, a note receivable is a short-term obligation owed to the company based on a formal written document.

7. In conformity with the matching principle, the allowance method records bad debt expense in the same period in which the credit was granted and the sale was made.

8. Using the allowance method, bad debt expense is recognized in the period in which the sale related to the uncollectible account was recorded.

9. The write-off of bad debts using the allowance method decreases the asset accounts receivable and the contra asset allowance for doubtful accounts by the same amount. As a consequence, (a) net income is unaffected and (b) accounts receivable, net, is unaffected.

10. An increase in the receivables turnover ratio generally indicates faster collection of receivables. A higher receivables turnover ratio reflects an increase in the number of times average trade receivables were recorded and collected during the period.

11. Cash includes money and any instrument, such as a check, money order, or bank draft, which banks normally will accept for deposit and immediate credit to the depositor’s account. Cash equivalents are short-term investments with original maturities of three months or less that are readily convertible to cash, and whose value is unlikely to change (e.g., bank certificates of deposit and treasury bills).

12. The primary characteristics of an internal control system for cash are: (a) separation of the functions of cash receiving from cash payments, (b) separation of cash-receiving and cash-paying routines, (c) separation of the physical handling of cash from the accounting function, (d) deposit all cash receipts and make all cash payments by check, (e) require separate approval of all checks and electronic funds transfers, and (f) require monthly reconciliation of bank accounts.

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13. Cash-handling and cash-recording activities should be separated to remove the opportunity for theft of cash and a cover-up by altering the records. This separation is accomplished best by assigning the responsibility for cash handling to individuals other than those who have the responsibility for recordkeeping. In fact, it usually is desirable that these two functions be performed in different departments of the business.

14. The purposes of a bank reconciliation are (a) to determine the “true” cash balance and (b) to provide data to adjust the Cash account to that balance. A bank reconciliation involves reconciling the balance in the Cash account at the end of the period with the balance shown on the bank statement (which is not the “true” cash balance) at the end of that same period. Seldom will these two balances be identical because of such items as deposits in transit; that is, deposits that have been made by the company but not yet entered on the bank statement. Another cause of the difference is outstanding checks, that is, checks that have been written and recorded in the accounts of the company that have not cleared the bank, hence they have not been deducted from the bank's balance. Usually the reconciliation of the two balances, per books against per bank, requires recording of one or more items that are reflected on the bank statement but have not been recorded in the accounting records of the company. An example is the usual bank service charge.

15. The total amount of cash that should be reported on the balance sheet is the sum of (a) the true cash balances in all checking accounts (verified by a bank reconciliation of each checking account), (b) cash held in all “cash on hand” (or “petty cash”) funds, and (c) any cash physically on hand (any cash not transferred to a bank for deposit—usually cash held for change purposes).

16. (Based on Supplement A) Under the gross method of recording sales discounts, the amount of sales discount taken is recorded at the time the collection of the account is recorded.

ANSWERS TO MULTIPLE CHOICE

1. d) 2. b) 3. b) 4. d) 5. b)6. c) 7. d) 8. b) 9. d) 10. c)


Authors' Recommended Solution Time

(Time in minutes)

Mini-exercises Exercises ProblemsAlternate Problems

Cases and Projects

No. Time No. Time No. Time No. Time No. Time1 5 1 15 1 25 1 35 1 252 5 2 15 2 35 2 35 2 303 10 3 15 3 20 3 50 3 354 10 4 20 4 35 4 40 4 355 10 5 20 5 50 5 45 5 406 10 6 30 6 40 6 457 10 7 30 7 40 7 208 10 8 15 8 45 8 359 10 9 15 9 45 9 *

10 15 10 4511 15 11 4512 2013 2014 3015 1516 2017 3018 1519 2020 2021 2022 2023 3024 30

* Due to the nature of these cases and projects, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time to discussing research strategies. When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.


MINI-EXERCISES

M6–1.

Transaction Point A Point B(a) Airline tickets sold by an airline on a

credit card Point of sale x Completion of flight(b) Computer sold by mail order

company on a credit card x Shipment Delivery(c) Sale of inventory to a business

customer on open account x Shipment Collection of account

M6–2.

If the buyer pays within the discount period, the income statement will report $1,960 as net sales ($2,000 x 0.98).

M6–3.

Credit card sales (R) $8,000Less: Credit card discount (XR) 240

Net credit card sales $7,760

Sales on account (R) $9,500Less: Sales returns (XR) 500

9,000Less: Sales discounts (1/2 x 9,000 x 2%) (XR) 90

Net sales on account $8,910Net sales (reported on income statement) $16,670

M6–4.

Gross Profit Percentage = Gross Profit = $56,000 – $48,000 = $8,000 = 0.143Net Sales $56,000 $56,000

The gross profit percentage is 14.3%. This ratio measures the excess of sales prices over the costs to purchase or produce the goods or services sold as a percentage. It indicates a company’s ability to charge premium prices and produce goods and services at lower cost.


M6–5.

(a) Allowance for doubtful accounts (XA) .......................17,000Accounts receivable (A)..................................... 17,000

To write off specific bad debts.

(b) Bad debt expense (E)................................................14,000Allowance for doubtful accounts (XA)................ 14,000

To record estimated bad debt expense.

M6–6.

Assets Liabilities Stockholders’ Equity

(a) Allowance for doubtful accounts –10,000

Bad debt expense –10,000

(b) Allowance for doubtful accounts +8,000

Accounts receivable –8,000

M6–7.

+ (a) Granted credit with shorter payment deadlines.+ (b) Increased effectiveness of collection methods.– (c) Granted credit to less creditworthy customers.

M6–8.

Reconciling Item + Company’s

BooksBank

Statement(a) Outstanding checks –(b) Bank service charge –(c) Deposit in transit +


M6–9. (Based on Supplement A)

A $700 credit sale with terms, 2/10, n/30, should be recorded as follows:

Accounts receivable (A)................................................ 700Sales revenue (R) ............................................. 700

This entry records the sale at the gross amount. If the customer does pay within the discount period, only $686 must be paid, in which case the entry for payment would be as follows:

Cash (A) ...................................................................... 686Sales discounts (XR) ................................................... 14

Accounts receivable (A) .................................... 700


EXERCISES

E6–1.Sales revenue ($1,000 + $800 + $500)..................................... $2,300Less: Sales discount ($1,000 collected from S. Green x 2%)... 20Net sales.................................................................................... $2,280

E6–2.Sales revenue ($1,000 + $5,000 +$3,000)................................ $9,000Less:

Sales discount ($5,000 collected from S x 3%)............... 150Credit card discount ($1,000 from R x 2%)..................... 20

Net sales.................................................................................... $8,830

E6–3.Sales revenue ($400 + $4,000 + $6,000).................................. $10,400Less: Sales returns and allowances (1/10 x $6,000 from D)........ 600Less: Sales discounts (9/10 x $6,000 from D x 3%)..................... 162Less: Credit card discounts ($400 from B x 2%)....................... 8Net sales.................................................................................... $9,630

E6–4.

Income fromTransaction Net Sales Gross Profit Operations

July 12 + + +July 15 + + +July 20 NE NE –July 21 – – –

E6–5.

Req. 1. (Amount saved ÷ Amount paid) = Interest rate for 50 days. (3% ÷ 97%) = 3.09% for 50 days.

Interest rate for 50 days x (365 days ÷ 50 days) = Annual interest rate 3.09% x (365 ÷ 50 days) = 22.6%

Req. 2. Yes, because the 15% rate charged by the bank is less than the 22.6% rate implicit in the discount. The company will earn 7.6% by doing so (22.6% – 15%).


E6–6.

Req. 1SLATE, INCORPORATED

Income StatementFor the Year Ended December 31, 2004

PercentageAmount Analysis

Gross sales ($220,000 + $32,000).................... $252,000Less sales returns and allowances.................... 7,000Net sales revenue.............................................. 245,000 100%Cost of goods sold............................................. 147,000 60%Gross profit ....................................................... 98,000 40%Operating expenses: Administrative expense.................................... $19,000 Selling expense............................................... 40,200 Bad debt expense ($32,000 x 2.5%)............... 800 60,000 24%Income from operations..................................... 38,000 16% Income tax expense ($38,000 x 30%)............. 11,400 5%Net income......................................................... $ 26,600 11%

Earnings per share ($26,600 ÷ 5,000 shares) $5.32

Req. 2

Gross profit margin: $245,000 – $147,000 = $98,000.

Gross profit percentage ratio: $98,000 ÷ $245,000 = .40 (or 40%).

Gross margin or gross profit in dollars is the difference between the sales prices and the costs of purchasing or manufacturing all goods that were sold during the period (sometimes called the markup); that is, net revenue minus only one of the expenses--cost of goods sold. The gross profit ratio is the amount of each net sales dollar that was gross profit during the period. For this company, the rate was 40%, which means that $.40 of each net sales dollar was gross profit (alternatively, 40% of each sales dollar was gross profit for the period).


E6–7.

Req. 1WOLVERINE WORLD WIDE INC.

Income StatementFor the Year Ended

PercentageAmount Analysis

Net sales revenue.............................................. $ 413,957 100%Cost of products sold......................................... 290,469 70%Gross profit........................................................ 123,488 30%Operating expenses:Selling and administrative expense................... 85,993 21%Income from operations..................................... 37,495 9%Other income (expense): Interest expense.............................................. $ (3,678) Other income................................................... 297 (3,381 ) 1%Pretax income.................................................... 34,114 8%Income tax expense ......................................... 10,047 2%Net income......................................................... $ 24,067 6%

Earnings per share ($24,067 ÷ 17,114 shares) $1.41

Req. 2

Gross profit margin: $413,957 – $290,469 = $123,488.

Gross profit percentage ratio: $123,488 ÷ $413,957 = .30 (or 30%).

Gross margin or gross profit in dollars is the difference between the sales prices and the costs of purchasing or manufacturing all goods that were sold during the period (sometimes called the markup); that is, net revenue minus only one of the expenses--cost of goods sold. The gross profit ratio is the amount of each net sales dollar that was gross profit during the period. For this company, the rate was 30%, which means that $.30 of each net sales dollar was gross profit (alternatively, 30% of each sales dollar was gross profit for the period).

Wolverine World Wide's gross profit percentage was well below Timberland's current (2000) percentage of 46.6% and even below Timberland’s 1998 percentage of 39.8%. Timberland shoes have a reputation as a rugged product as well as a premium "high fashion" product. This has allowed it to maintain higher prices and higher gross margins. In marketing this is called the value of brand equity.


E6–8.

(a) Bad debt expense (E) ($650,000 x 0.015).................9,750Allowance for doubtful accounts (XA)................ 9,750


(b) Allowance for doubtful accounts (XA) ....................... 1,000Accounts receivable (A)..................................... 1,000

To write off a specific bad debt.

E6–9.

(a) Bad debt expense (E) ($720,000 x 0.005).................3,600Allowance for doubtful accounts (XA)................ 3,600


(b) Allowance for doubtful accounts (XA) ....................... 300Accounts receivable (A)..................................... 300


E6–10.

Assets Liabilities Stockholders’ Equity

(a) Allowance for doubtful accounts –3,600

Bad debt expense –3,600

(b) Allowance for doubtful accounts +300

Accounts receivable –300

E6–11.

(a) Bad debt expense (E) ($650,000 x 0.02)...................13,000Allowance for doubtful accounts (XA)................ 13,000


(b) Allowance for doubtful accounts (XA) ....................... 1,600Accounts receivable (A)..................................... 1,600


Income fromTransaction Net Sales Gross Profit Operations

a. NE NE –b. NE NE NE


E6–12.

1. Bad debt expense (E) ............................................................ 92Allowance for doubtful accounts (XA)........................... 92

To estimate bad debt expense.

Allowance for doubtful accounts (XA)..................................... 52Accounts receivable (A)................................................ 52

To write off specific bad debts.

2. It would have no effect because the asset “Accounts receivable” and contra-asset “Allowance for doubtful accounts” would both decline by DM 10 million. Neither “Receivables, net” nor “Net income” would be affected.

E6–13.

1. Allowance for doubtful accounts

57 Beg. balance

Write-offs 28 47 Bad debt exp.

76 End. balance

Bad debt expense increases (is credited to) the allowance. Since we are given the beginning and ending balances in the allowance, we can solve for write-offs, which decrease (are debited to) the allowance.

2. Accounts Receivable

Beg. balance* 327 28 Write-offs

Net sales 3,753 3,638 Cash collections

End. balance ** 414

* 270 + 57 ** 338 + 76

Accounts receivable gross is increased by recording credit sales and decreased by recording cash collections and write-offs of bad debts. Thus, we can solve for cash collections as the missing value.


E6–14.

Req. 1

The allowance for doubtful accounts is increased (credited) when bad debt expense is recorded and decreased (debited) when uncollectible accounts are written off. This case gives the beginning and ending balances of the allowance account and the amount of uncollectible accounts that were written off. Therefore, the amount of bad debt expense can be computed as follows:

Allowance for doubtful accounts

(c) 69,000,000 (a) 86,605,000(d) 79,384,000(b) 96,989,000

(a) Beginning balance, given(b) Ending balance, given(c) Uncollectible accounts write-off, given(d) Bad debt expense, plug amount to balance

Req. 2

Working capital is unaffected by the write-off of an uncollectible account when the allowance method is used. The asset account (accounts receivable) and the contra- asset account (allowance for doubtful accounts) are both reduced by the same amount; therefore, the book value of net accounts receivable is unchanged.

Working capital is decreased when bad debt expense is recorded because the contra- asset account (allowance for doubtful accounts) is increased. From requirement (1), we know that net accounts receivable was reduced by $79,384,000 when bad debt expense was recorded in year 2.

Note that income before taxes was reduced by the amount of bad debt expense that was recorded, therefore tax expense and tax payable will decrease. The decrease in tax payable caused working capital to increase; therefore, the net decrease was $79,384,000 – ($79,384,000 x 30%) = $55,568,800.

Req. 3

The entry to record the write-off of an uncollectible account did not affect any income statement accounts; therefore, net income is unaffected by the $69,000,000 write-off in year 2.

The recording of bad debt expense reduced income before taxes in year 2 by $79,384,000 and reduced tax expense by $23,815,200 (i.e., $79,384,000 x 30%). Therefore, year 2 net income was reduced by $55,568,800 (as computed in Req. 2).


E6–15.

Aged accounts receivable

Estimated percentage uncollectible

Estimated amount

uncollectibleNot yet due $12,000 x 2% = $240Up to 120 days past due 5,000 x 10% = 500Over 120 days past due 3,000 x 30% = 900Estimated balance in Allowance for Doubtful Accounts $1,640Current balance in Allowance for Doubtful Accounts 300Bad Debt Expense for the year $1,340

E6–16.

Req. 1

December 31, 2005-Adjusting entry:Bad debt expense (E)................................................... 3,650

Allowance for doubtful accounts (XA)................ 3,650To adjust for estimated bad debt expense for 2005 computed as follows:

Aged accounts receivable

Estimated percentage uncollectible

Estimated amount

uncollectibleNot yet due $65,000 x 1% = $650Up to 180 days past due 10,000 x 15% = 1,500Over 180 days past due 4,000 x 40% = 1,600Estimated balance in Allowance for Doubtful Accounts $3,750Current balance in Allowance for Doubtful Accounts 100Bad Debt Expense for the year $3,650

Req. 2Balance sheet:

Accounts receivable ($65,000 + $10,000 + $4,000) $79,000Less allowance for doubtful accounts..................... 3,750

Accounts receivable, net of allowance for doubtful accounts......................................... $75,250


E6–17.

Req. 1

Dec. 31, 2009Allowance for doubtful accounts (XA)........................ 1,500

Accounts receivable (J. Doe) (A).................... 1,500To write off an account receivable determined to

be uncollectible.

Dec. 31, 2009Bad debt expense (E) ............................................... 1,700

Allowance for doubtful accounts (XA)............. 1,700Adjusting entry--estimated loss on uncollectible accounts; based on credit sales ($85,000 x 2% = $1,700).

Req. 2

Income statement:Operating expenses:

Bad debt expense........................................................ $1,700

Balance sheet:Current assets

Accounts receivable ($10,000 + $85,000 - $68,000 - $1,500) ...................................... $25,500Less: Allowance for doubtful accounts ($800 - $1,500 + $1,700) ............................. 1,000 $24,500

Req. 3

The 2% rate on credit sales appears reasonable because it approximates the amount of receivables written off ($1,500) during the year. However, if the uncollectible account receivable written off during 2009 is not indicative of average uncollectibles written off over a period of time, the 2% rate may not be appropriate. There is not sufficient historical data to make a definitive decision.


E6–18.

Req. 1

Receivables turnover = Net Sales = $7,015,069 = 7.95 timesAverage Net Trade

Accounts Receivable$882,539*

Average days sales = 365 = 365 = 45.9 daysin receivables Receivables Turnover 7.95

* ($997,808 + $767,270) ÷ 2

Req. 2

The receivables turnover ratio reflects how many times average trade receivables were recorded and collected during the period. The average days sales in receivables indicates the average time it takes a customer to pay its account.

E6–19.

Req. 1

$55,500 Unadjusted net trade accounts receivable (6,500 ) Bad debt expense adjustment ($650,000 x .01)

49,000 End-of-the-year balance50,000 Beginning-of-the-year balance

$49,500 Average net trade accounts receivable ($49,000 + $50,000) 2

Receivables turnover = Net Sales = $650,000 = 13.1 timesAverage Net Trade

Accounts Receivable$49,500

Req. 2

Same answer as part 1.

Req. 3

The two amounts do not differ because the write-off of an account does not change net trade accounts receivable. A write-off simultaneously decreases gross accounts receivable and the allowance for doubtful accounts, leaving the net trade accounts receivable balance unchanged.


E6–20.

Req. 1

The change in the accounts receivable balance would increase cash flow from operations by $15,337 thousand. This happens because the Company is collecting cash faster than it is recording credit sales revenue.

Req. 2

(a) Declining sales revenue leads to lower accounts receivable because fewer new credit sales are available to replace the receivables that are being collected.

(b) Cash collections from prior period's higher credit sales are greater than the new credit sales revenue. Note that in the next period, cash collections will also decline.

E6–21.

Req. 1

The change in the accounts receivable balance would decrease cash flow from operations by $292,888 thousand. This happens because the Company is recording credit sales revenue faster than it is collecting cash.

Req. 2

(a) Increasing sales revenue leads to higher accounts receivable balances because credit sales are creating new receivables faster than receivables can be collected.

(b) Cash collections from prior period's lower credit sales are lower than the new credit sales revenue. Note that in the next period, cash collections will also rise.


E6–22.

Req. 1

JONES COMPANYBank Reconciliation, June 30, 2004

Company's Books Bank Statement

Ending balance per Cash account……………………… $7,400

Ending balance per bank statement……………… $6,050

Additions: Additions:

None Deposit in transit………… 2,000 * 8,050

Deductions: Deductions:

Bank service charge…… 50 Outstanding checks… 700 Correct cash balance……… $7,350 Correct cash balance…… $7,350

*$19,000 – $17,000 = $2,000.

Req. 2

Bank service charge expense (E).............................................. 50Cash (A).......................................................................... 50

To record deduction from bank account for service charges.

Req. 3

The correct cash balance per the bank reconciliation ($7,400 – $50), $7,350

Req. 4

Balance sheet (June 30, 2004):Current assets:

Cash ($7,350 + $300)......................................................... $7,650


E6–23.

Req. 1RUSSELL COMPANY

Bank Reconciliation, September 30, 2006

Company's Books Bank StatementEnding balance per Cash account........................... $5,700

Ending balance per bank statement........................ $4,600

Additions: Additions:

None Deposit in transit*......... 1,000 * 5,600

Deductions: Deductions:

Bank service charges... $ 50 NSF check – Betty Brown............. 150 200

Outstanding checks ($28,600 – $28,500).... 100

Correct cash balance....... $5,500 Correct cash balance....... $5,500

*$28,000 - $27,000 = $1,000.

Req. 2

(1) Bank service charge expense (E)........................................... 50Cash (A)....................................................................... 50

To record bank service charges deducted from bank balance.

(2) Accounts receivable (Betty Brown) (A)................................... 150Cash (A)....................................................................... 150

To record customer check returned due to insufficient funds.

Req. 3

Same as the correct balance on the reconciliation, $5,500.

Req. 4

Balance Sheet (September 30, 2006):Current Assets:Cash ($5,500 + $400)................................................................... $5,900


E6–24 (Based on Supplement A)

November 20, 2004Cash (A)....................................................................... 392Credit card discount (XR)............................................. 8

Sales revenue (R).............................................. 400To record credit card sale.

November 25, 2004:Accounts receivable (Customer C) (A)......................... 4,000

Sales revenue (R).............................................. 4,000To record a credit sale.

November 28, 2004:Accounts receivable (Customer D) (A)......................... 6,000

Sales revenue (R).............................................. 6,000To record a credit sale.

November 30, 2004:Sales returns and allowances (XR).............................. 600

Accounts receivable (Customer D) (A).............. 600To record return of defective goods $6,000 x 1/10 = $600.

December 6, 2004:Cash (A)....................................................................... 5,238Sales discounts (XR).................................................... 162

Accounts receivable (Customer D) (A).............. 5,400To record collection within the discount period,

97 × ($6,000 – $600) = $5,238

December 30, 2004:Cash (A)....................................................................... 4,000

Accounts receivable (Customer C) (A).............. 4,000To record collection after the discount period.


PROBLEMS

P6–1.

Case A

Because McDonald's collects cash when the coupon books are sold, cash collection is not an issue in this case. In order to determine if the revenue has been earned, the student must be careful in analyzing what McDonald's actually sold. Students who focus on the sale of the coupon book often conclude that the earning process is complete with the delivery of the book to the customer. In reality, McDonald's has a significant additional service to perform; it has to serve a meal. The correct point for revenue recognition in this case is when the customer uses the coupon or when the coupon expires and McDonald's has no further obligation.

Case B

In this case there is an extremely low down payment and some reason to believe that Quality Builders may default on the contract because of prior actions. If students believe that Howard Development could sue and collect on the contract, they will probably argue for revenue recognition. Given the risk of cash collection, most students will argue that revenue should be recognized as cash is collected. The text does not discuss FASB #66, but the instructor may want to mention during the discussion that there is authoritative guidance concerning minimum down payments before revenue can be recorded on a land sale.

Case C

While warranty work on refrigerators can involve significant amounts of effort and money, companies are permitted to record revenue at the point of sale. The text does not discuss this specific issue but the matching concept is mentioned in the context of revenue recognition. This is an excellent opportunity to mention the need to accrue estimated warranty expense at the time that sales revenue is recorded. Some students are surprised to see that costs that will be incurred in the future can be recorded as an expense in the current accounting period.


P6–2.

Req. 1

Sales Revenue

Sales Discounts (taken)

Sales Returns and Allowances

Bad Debt Expense

(a) +228,000 NE NE NE(b) +12,000 NE NE NE(c) +26,000 NE NE NE(d) NE NE +500 NE(e) +24,000 NE NE NE(f) NE +230 NE NE(g) NE +2,000 NE NE(h) NE +520 NE NE(i) +17,000 NE NE NE(j) NE –70 +3,500 NE(k) NE NE NE NE(l) NE NE NE NE(m) NE NE NE +750*Total +$307,000 +$2,680 +$4,000 +$750

* Credit sales ($12,000 + $26,000 + $24,000 + $17,000). $79,000Less: Sales returns ($500 + $3,500).............................. 4,000Net sales revenue........................................................... $75,000Estimated bad debt rate.................................................. x 1%Bad debt expense........................................................... $750

Req. 2

Income statement:Sales revenue............................................................ $307,000

Less: Sales returns and allowances.............. 4,000Sales discounts.................................... 2,680

Net sales revenue...................................................... $300,320Bad debt expense...................................................... 750


P6–3.

Income Statement Items Case A Case B Note–See below Note–See below

Gross sales revenue............................. $160,000* $232,000*Sales returns and allowances............... h. 16,250 18,000*Net sales revenue................................. g. 143,750 a. 214,000Cost of goods sold................................. i. (68%*) 97,750 c. 149,800Gross profit............................................ f. 46,000 b. (30%*) 64,200Operating expenses.............................. 18,500* d. 44,200Pretax income....................................... d. 27,500 20,000*Income tax expense (20%)*.................. e. 5,500 e. 4,000Income before extraordinary items........ c. 22,000 f. 16,000Extraordinary items............................... (gain*) 10,000* (loss*) (2,000)* Less: Income tax (20%)*................. b. (2,000 ) g. 400Net income............................................ a. $30,000 h. $ 14,400Earnings per share (10,000 shares*).. . . $3.00* i. $1.44

*Amounts given.

Note = Computations in order

CASE Aa. $3.00 x 10,000 shares = $30,000b. $10,000 x .20 = $2,000c. $30,000 – ($10,000 - $2,000) = $22,000d. $22,000 ÷ (1.00 - .20) = $27,500e. $27,500 x .20 = $5,500f. $27,500 + $18,500 = $46,000g. $46,000 ÷ (1.00 - .68) = $143,750h. $160,000 – $143,750 = $16,250i. $143,750 x .68 = $97,750

CASE Ba. $232,000 – $18,000 = $214,000b. $214,000 x .30 = $64,200c. $214,000 – $64,200 = $149,800d. $64,200 – $20,000 = $44,200e. $20,000 x .20 = $4,000f. $20,000 – $4,000 = $16,000g. $2,000 x .20 = $400h. $16,000 – $2,000 + $400 = $14,400i. $14,400 ÷ 10,000 shares = $1.44


P6–4.

1. Bad debt expense (E)................................................................ 4.5Allowance for doubtful accounts (XA)............................. 4.5

End-of-period bad debt expense estimate.

Allowance for doubtful accounts (XA)........................................ 2.7Accounts receivable (A).................................................. 2.7

Write-off of bad debts.

Accounts receivable(A) ............................................................. .2Allowance for doubtful accounts (XA) ............................ .2

Reinstatement of previously written-off accounts. Note that the collection of the cash would also be recorded.

2. Year 2........................................ $7.1 $4.8 – $3.7...........................$8.2

Year 1........................................ $6.4 $3.8 $.2$3.3 $7.1

Allowance for DA Year 2 Allowance for DA Year 1

7.1 Beg. bal. 6.4 Beg. bal

Write-offs 3.7 4.8 Bad debt exp. Write-offs 3.3 3.8 Bad debt exp.

8.2 End. bal. .2 Reinstatments

7.1 Ending Bal.

The solution involves solving for the missing value in the T-account.


P6–5.

Req. 1Aging Analysis of Accounts Receivable

CustomerTotal

Receivables(a) Not Yet

Due

(b) Up to One Year Past Due

(c) More Than One Year Past Due

B. Brown………….. $ 5,000 $5,000

D. Donalds……….. 4,000 $ 4,000

N. Napier…………. 7,000 $ 7,000

S. Strothers……… 19,000 3,000 16,000

T. Thomas………... 6,000 6,000

Totals…………… $41,000 $16,000 $20,000 $5,000

Percent…………. 100% 39% 49% 12%

Req. 2Estimated Amounts Uncollectible

AgeAmount of Receivable

Estimated Loss Rate

Estimated Uncollectible

a. Not yet due…………………… $16,000 1% $ 160b. Up to one year past due……. 20,000 5% 1,000c. Over one year past due…….. 5,000 30% 1,500

Total……………………….. $41,000 $2,660

Req. 3

Bad debt expense (E)..................................................... 1,640Allowance for doubtful accounts (XA).................... 1,640

To adjust for estimated bad debt loss:Balance needed in the allowance account................................................. $2,660Balance currently in the account.............. 1,020Adjustment needed (increase)................. $1,640

Req. 4

Income statement:Bad debt expense........................................................... $1,640

Balance sheet:Current Assets:

Accounts receivable........................................................ $41,000Less: Allowance for doubtful accounts........................... 2,660

Carrying value....................................................... $38,340


P6–6.

Req.1BUILDERS COMPANY, INC.


Net sales revenue ($182,000 $8,000 $7,000).................. 167,000Cost of goods sold................................................................ 98,000Gross profit on sales............................................................. 69,000Operating expenses:

Selling expense............................................................ $17,000Administrative expense................................................ 18,000Bad debt expense........................................................ 2,000 37,000

Operating income................................................................. 32,000Income tax expense..................................................... 9,600

Net income ........................................................................ $22,400

Earnings per share on capital stock outstanding ($22,400 ÷ 10,000 shares)................................................................. $2 .24

Req.2

Gross Profit Percentage = Gross Profit = $69,000 = 0.413 (41.3%)Net Sales $167,000

The gross profit percentage measures the excess of sales prices over the costs to purchase or produce the goods or services sold as a percentage.


P6–7.

Req.1

Projected change

No change from beginning of year

Receivables = Net Sales $7,015,069 = 8.7 $7,015,069 = 7.3Turnover Average Net Trade

Accounts Receivable$807,039* $963,808

* ($963,808 + $650,270) ÷ 2

Req.2

Projected decrease in accounts receivable = $963,808 – $650,270 = $313,538

A decrease in accounts receivable would increase cash, all other items held equal.

Req.3

An increase in the receivables turnover ratio indicates that there has been an increase in the number of times average trade receivables were recorded and collected during the period. All other things equal, this indicates an increase in the rate at which receivables are collected, which will increase cash flow from operating activities for the period. This can benefit the company by providing additional liquidity for the company in its day to day operations, reducing the need for additional borrowing.


P6–8.

Req. 1(a) $50 x 12 months = $ 600(b) $12 x (52 weeks x 5 days per week) = 3,120(c,d) Accounts receivable collections ($300 + $800) = 1,100

Total approximate amount stolen $4,820

Req. 2

Basic recommendations:

(1) Install a tight system of internal control, including the following:

a. Separate cash handling from recordkeeping.

b. Deposit all cash daily.

c. Make all payments by check. Consider a separate cash on hand system for small expense payments.

d. Reconcile bank statement monthly.

e. Institute a system of spot checks.

f. Establish cash and paperwork flows.

(2) a. Arrange for an annual independent audit on a continuing basis.

b. Carefully plan and assign definite responsibilities for all employees. Focus on attaining internal control. Isolate the once trusted employee from all cash handling and accounting activities.


P6–9.

Req. 1HOPKINS COMPANY

Bank Reconciliation, April 30, 2006Company's Books Bank Statement

Ending balance per Cash account.......................... $21,450

Ending balance per bank statement...................... $18,530

Additions: Additions:Interest collected................ 1,070 Deposits in transit*.............. 6,000

22,520 24,530

Deductions: Deductions:NSF—A.B. Wright.............. 140 Outstanding checks............ 2,200Bank charges..................... 50 190 Correct cash balance.......... $22,330 Correct cash balance.......... $22,330 *$42,000 - $36,000 = $6,000.

Req. 2(1) Cash (A)............................................................................. 1,070

Interest revenue (R)................................................ 1,070Interest collected.

(2) Accounts receivable (A. B. Wright) (A).............................. 140Cash (A).................................................................. 140

Customer's check returned, insufficient funds.

(3) Bank service charge expense (E)...................................... 50Cash (A).................................................................. 50

Bank service charges deducted from bank statements.

These entries are necessary because of the changes to the regular Cash account that have not yet been recorded by the company. The bank already has recorded them in its accounts. The Cash account (and the other accounts in the entries) must be brought up to date for financial statement purposes.

Req. 3Balance in regular Cash account....................................................... $22,330Balance Cash on Hand account........................................................ $ 100

Req. 4Balance Sheet (April 30,2006):

Current Assets:Cash ($22,330 + $100)................................................. $22,430


P6–10.

Req. 1Comparison of deposits listed in the Cash account with deposits listed on the bank statement reveals a $5,000 deposit in transit on August 31.

Req. 2Comparison of the checks cleared on the bank statement with (a) outstanding checks from July, and (b) checks written in August reveals two outstanding checks at the end of August ($290 + $550 = $840).

Req. 3 MARTHA COMPANYBank Reconciliation, August 31, 2004

Company's Books Bank StatementEnding balance per Cash account.......................... $20,280


Additions: Additions:Interest collected................ 2,180 Deposits in transit............... 5,000

22,460 23,200

Deductions: Deductions:Bank service charges........................... 100 Outstanding checks............ 840 Correct cash balance........................... $22,360 Correct cash balance.......... $22,360

Req. 4(1) Cash (A)............................................................................. 2,180

Interest revenue (R)................................................ 2,180Interest collected.

(2) Bank service charge expense (E) ..................................... 100Cash (A).................................................................. 100

Service charges deducted from bank balance.

These entries are necessary because of the changes in the regular Cash account that have not yet been recorded by the company. The bank already has recorded them in its accounts. The Cash account (and the other accounts in the entries) must be brought up to date for financial statement purposes.

Req. 5Balance in Cash account......................................................................... $22,360Balance in Cash on Hand account.......................................................... $ 200

Req. 6Current Assets:

Cash ($22,360 + $200)................................................................. $22,560


P6–11. (Based on Supplement A)

Req. 1

(a) Cash (A)..................................................................... 228,000Sales revenue (R)........................................... 228,000

Cash sales for 2005.

(b) Accounts receivable (R. Jones) (A)........................... 12,000Sales revenue (R)........................................... 12,000

Credit sale, $12,000.

(c) Accounts receivable (K. Black) (A)............................ 26,000Sales revenue (R)........................................... 26,000


(d) Sales returns and allowances (XR)........................... 500Accounts receivable (R. Jones) (A)................ 500

Sale return, 1 unit @ $500.

(e) Accounts receivable (B. Sears) (A)............................ 24,000Sales revenue (R)........................................... 24,000


(f) Cash (A)..................................................................... 11,270Sales discount (XR)................................................... 230

Accounts receivable (R. Jones) (A)................ 11,500Paid account in full within discount period,($12,000 - $500) x (1 - .02) = $11,270.

(g) Cash (A)..................................................................... 98,000Sales discount (XR)................................................... 2,000

Accounts receivable (prior year) (A)............... 100,000Collected receivables of prior year, all within discount periods $98,000 ÷ .98 = $100,000.

(h) Cash (A)..................................................................... 25,480Sales discount (XR)................................................... 520

Accounts receivable (K. Black) (A).................. 26,000Collected receivable within the discount period$26,000 x .98.

(i) Accounts receivable (R. Roy) (A).............................. 17,000Sales revenue (R)........................................... 17,000

Credit sale.


P6–11. (continued)

(j) Sales returns and allowances (XR)........................... 3,500Cash (A).......................................................... 3,430Sales discounts (XR)....................................... 70

Sales return, 7 units @ $500 less sales discounts taken = $3,500 x .98.

(k) Cash (A)..................................................................... 7,000Accounts receivable (A).................................. 7,000

Collected receivable of prior year, after the discountperiod.

(l) Allowance for doubtful accounts (XA)........................ 2,900Accounts receivable (2003 account) (A)......... 2,900

Wrote off uncollectible account from 2003.

(m) Bad debt expense (E)................................................ 750Allowance for doubtful accounts (XA)............. 750

To adjust for estimated bad debt expense ($12,000 +$26,000 + $24,000 + $17,000 – $500 – $3,500)x 1% = $750.

Req. 2

Income statement:Sales revenue ($228,000 + $12,000 + $26,000

+ $24,000 + $17,000)...................................... $307,000Less: Sales returns and allowances ($3,500 + $500)............... 4,000

Sales discounts ($230 + $2,000 + $520 – $70)..................................... 2,680

Net sales revenue ............................................................. $300,320Bad debt expense ............................................................. 750


ALTERNATE PROBLEMS

AP6–1.

Req. 1

Sales Revenue

Sales Discounts (taken)

Sales Returns and Allowances

Bad Debt Expense

(a) +122,000 NE NE NE(b) +6,800 NE NE NE(c) +14,000 NE NE NE(d) NE +204 NE NE(e) +12,400 NE NE NE(f) NE -48 +1,600 NE(g) NE +2,412* NE NE(h) NE NE +800 NE(i) NE +396 NE NE(j) +9,000 NE NE NE(k) NE NE NE NE(l) NE NE NE NE(m) NE NE NE +796**Total +$164,200 +$2,964 +$2,400 +$796

* [(78,000/.97) x .03] = 2,412

**Credit sales ($6,800 + $14,000 + $12,400 + $9,000)..... $42,200Less: Sales returns ($1,600 + $800).............................. 2,400Net sales revenue........................................................... $39,800Estimated bad debt rate.................................................. x 2%Bad debt expense........................................................... $796

Req. 2

Income statement:Sales revenue............................................................ $164,200

Less: Sales returns and allowances.............. 2,400Sales discounts.................................... 2,964

Net sales revenue...................................................... $158,836Bad debt expense...................................................... $796


AP6–2.

1. Bad debt expense (E)................................................................4,908Allowance for doubtful accounts (XA)............................. 4,908

End of period bad debt expense estimate.

Allowance for doubtful accounts (XA)........................................5,060Accounts receivable (A).................................................. 5,060

Write-off of bad debts.

2.Allowances for

Doubtful Accounts and

Discounts

Balance at Beginning

of Year

Additions Charged to Costs and Expenses

Deductions From

Reserve

Balance at End

of Year

Year 3 $2,032 $4,908 $5,060 $1,880

Year 2 1,234 5,475 4,677 2,032

Year 1 940 5,269 4,975 1,234

Year 3 Allowance for Doubtful Accounts

2,032 Beg. bal.

Write-offs 5,060 4,908 Bad debt exp.

1,880 End. bal.


1,234 Beg. bal.


2,032 End. bal.


940 Beg. bal


1,234 Ending bal.

The solution involves solving for the missing value in the T-account.


AP6–3.

Req. 1Aging Analysis of Accounts Receivable

CustomerTotal

Receivable

(a) Not Yet

Due

(b) Up to 6 Mo.

Past Due

(c) 6 to

12 Mo. Past Due

(d) More Than

12 Mo. Past Due

R. Devens ……….. $ 2,000 $2,000

C. Howard ……….. 6,000 $6,000

D. McClain .………. 4,000 $ 4,000

T. Skibinski ……… 14,500 $ 4,500 10,000

H. Wu ………..…... 13,000 13,000

Totals…………… $39,500 $17,500 $14,000 $2,000 $6,000

Percent…………. 100% 44.3% 35.4% 5.1% 15.2%

Req. 2Estimated Amounts Uncollectible

AgeAmount of Receivable

Estimated Loss Rate

Estimated Uncollectible

a. Not yet due…………………… $17,500 1% $ 175b. Up to 6 months past due...…. 14,000 5% 700c. 6 to 12 months past due.…. 2,000 20% 400d. Over 12 months past due…... 6,000 50% 3,000

Total……………………….. $39,500 $4,275

Req. 3Bad debt expense (E) .................................................... 2,725

Allowance for doubtful accounts (XA) ................... 2,725

To adjust for estimated bad debt loss:Balance needed in the allowance account................................................. $4,275Balance currently in the account.............. 1,550Adjustment needed (increase)................. $2,725

Req. 4Income statement:

Bad debt expense........................................................... $2,725Balance sheet:Current Assets:

Accounts receivable........................................................ $39,500Less: Allowance for doubtful accounts........................... 4,275

Carrying value....................................................... $35,225


AP6–4.

Req. 1BIG TOMMY CORPORATION


Net sales revenue ($420,000 - $10,000)............................ 410,000Cost of goods sold.............................................................. 279,000Gross profit......................................................................... 131,000Operating expenses:

Selling expense........................................................... $58,000Administrative and general expense........................... 16,000Sales discounts........................................................... 6,000Bad debt expense....................................................... 1,000

Total operating expenses................................... 81,000Income from operations...................................................... 50,000

Income tax expense.................................................... 15,000Net income.......................................................................... $35,000

Earnings per share on common stock outstanding ($35,000 ÷ 6,000 shares)................................................................... $5 .83

Req. 2

Gross Profit Percentage = Gross Profit = $131,000 = 0.320 (32.0%)Net Sales $410,000

The gross profit percentage measures the excess of sales prices over the costs to purchase or produce the goods or services sold as a percentage.


AP6–5.

Req. 1

Comparison of (a) the unrecorded deposit carried over from November and (b) the deposits listed on the bank statement reveals that the $13,000 deposit for December 31 is in transit.

Req. 2

Comparison of the checks cleared on the bank statement with (a) outstanding checks from November and (b) checks written in December reveals that the outstanding checks at the end of December are $5,000 + $3,300 + $500 = $8,800.

Req. 3

PACKER COMPANYBank Reconciliation, December 31, 2004

Company's Books Bank Statement

Ending balance per Cash account.......................... $61,260


Additions: Additions:Interest collected................ 5,250 Deposits in transit............... 13,000

66,510 74,860

Deductions: Deductions:NSF check—J. Left............. 300Bank service charges......... 150 450 Outstanding checks............ 8,800 Correct cash balance.......... $66,060 Correct cash balance.......... $66,060


AP6–5. (continued)

Req. 4

(1) Accounts receivable (J. Left) (A)..................................... 300Cash (A)............................................................... 300

To record NSF check.

(2) Cash (A).......................................................................... 5,250Interest revenue (R)............................................. 5,250

Interest collected.

(3) Bank service charge expense (E)................................... 150Cash (A)............................................................... 150

Service charges deducted from bank balance.

These entries are necessary because of the changes in the regular Cash account that have not yet been recorded by the company. The bank already has recorded them in its accounts. The Cash account (and the other accounts in the entries) must be brought up to date for financial statement purposes.

Req. 5

Cash account.......................................................................................... $66,060Cash on Hand account............................................................................ $ 300

Req. 6

Balance Sheet (2004):Current Assets:

Cash ($66,060 + $300)...................................................... $66,360


CASES AND PROJECTS

FINANCIAL REPORTING AND ANALYSIS CASES

CP6–1.

1. The company held $133,446 thousand of cash and cash equivalents at the end of the current year. This is disclosed on the balance sheet and the statement of cash flows.

2. No, the company does not report an allowance for doubtful accounts on the balance or in the notes. Note 5 provides additional information on the accounts receivable account. As a retailer, its trade receivables from customers are immaterial—the company’s receivables consist of non-trade receivables and notes receivable.

3.

2000 1999

Gross Profit = Gross Profit $436,225 = 0.399 $356,508 = 0.428Percentage Net Sales 1,093,477 832,104

The gross profit percentage decreased from 1999 to 2000. The decrease implies that the company has slightly worsened in its ability to charge premium prices or to purchase goods for resale at lower cost. This change might also imply that the company has decided to increase sales by slightly decreasing its prices.

4. Note 2 provides the summary of significant accounting policies. The company recognizes revenue upon the purchase of merchandise by customers. When stored value cards and gift certificates are sold, the company defers revenue recognition until the customer redeems the value in the card or certificate by purchasing goods.


CP6–2.

1. The company includes amounts on deposit with financial institutions and investments with original maturities of less than 90 days. This information is from note 2 of the financial statements. The amount disclosed is likely to be close to the fair market value of the securities, given the short maturity date.

2. In addition to Cost of Goods Sold, Abercrombie & Fitch subtracts occupancy and buying costs from Net Sales in its computation of Gross Profit. No such additional expenses appear to be subtracted in Timberland’s computation of Gross Profit. This makes the interpretation of gross profit percentages across different companies difficult.

3.Receivables turnover = Net Sales = $1,237,604 = 90.74 times

Average Net TradeAccounts Receivable

13,638

* ($15,829 + 11,447) ÷ 2

The receivables turnover is so high because of the nature of the company’s business. Retail sales are likely to be made with cash or credit card.

4. Receivables increased by $4,382 thousand, decreasing Net Cash Provided by Operating Activities for the current year. This is disclosed on the statement of cash flows (aggregated with other accounts in the category of “Other Assets and Liabilities”).


CP6–3.

1.

Current year Abercrombie & Fitch American Eagle Outfitters

Gross Profit = Gross Profit $509,375 = 0.412 $436,225 = 0.399Percentage Net Sales 1,237,604 1,093,477

Prior year Abercrombie & Fitch American Eagle Outfitters

Gross Profit = Gross Profit $450,383 = 0.437 $356,508 = 0.428Percentage Net Sales 1,030,858 832,104

In their MD&A sections, both firms state that the decrease is attributable to lower merchandise margins in 2000 compared to 1999. This is likely due to increased competition in their markets.

2. Companies with unique items for sale or valuable brand images often produce higher gross profit margins. Because American Eagle Outfitters and Abercrombie & Fitch have unique items for sale as well as valuable brand images in certain markets, their margins are predicted to be higher than the industry average.

3.

Industry Average

Abercrombie & Fitch

American Eagle Outfitters

Gross Profit Percentage = 36.55% 41.2% 39.9%

Both Abercrombie & Fitch’s and American Eagle Outfitters’ gross profit percentage are above the industry average. This is what was anticipated in Requirement 2.

4.

Abercrombie & Fitch 2000 1999

Receivables = Net Sales $1,237,604 = 90.7 $1,030,858 = 132.6Turnover Average Net Trade

Accounts Receivable13,638* 7,774.0**

* ($15,829 + 11,447) ÷ 2** ($11,447 + $4,101 given) ÷ 2

Abercrombie & Fitch’s Receivable’s Turnover declined in 2000 to 90.7 from 132.6 in 1999. This is due to a large increase in receivables relative to the increase in Net Sales. There is not enough information in the Abercrombie & Fitch Annual Report to discern the reason for the increase.


CP6–4.

Three main recommendations are made. First, establish a credit application process to verify creditworthiness. This would include obtaining credit reports (e.g., from Dun & Bradstreet, if available), bank information, trade references, and information on the responsible individuals (the owners and the officers of the company).

Second, once the credit process is in place, follow it. Customers who fail the credit application should not be extended credit. This may be harder than it sounds, since many incentives exist to increase sales revenue. Consider additional incentives for the sales force based on the collectability of the account—for example, a reduction in sales commissions for any accounts that remain uncollected after a specified period of time.

Third, monitor accounts receivable and follow up on slow payments. This includes sending out timely reminder notices and contacting the company directly with a phone call. After a certain amount of time, turn the unpaid bill over to a collection agency. Finally, if the account remains unpaid, notify trade or business organizations about the non-payment.


CP6–5.

1. Allowance for doubtful accounts = “Provision for doubtful debts”Bad debt expense = “Amounts set aside for doubtful debts”

2.Receivables turnover = Net Sales = $9,978,875 = 9.25 times

Average Net TradeAccounts Receivable

$1,078,526.5*

* ($792,193+$999,159) ÷ 2 + ($164,808+$200,893) ÷ 2

3.Trade debtors Other debtors

Provision for doubtful debts $121,449 = 0.153 $384 = 0.002Trade receivables $792,193 $192,330

The “other debtors” most likely include officers and employees of the company, related companies, and others who are much more likely to pay their debts than the average trade debtor.

4.

Allowance for doubtful accounts

247,974 Beg. bal. (238,110 + 2,464 + 7,400)

Write-Offs (solve) 139,592 21,371 Bad debt exp. (21,143 + 228)

129,753 End. bal. (121,449 + 384 + 7,920)


CRITICAL THINKING CASES

CP6–6.

Req. 1

The CPA was concerned because of the sequence of events as follows:

(a) The opening of a new Account Receivable of $2,500 (an unusually large amount and a “new” name unknown to the auditor).

(b) The write-off of bad debts at year-end rather than during the year.

(c) The nearness of the creation of the new account receivable of $2,500 to the write-offs of three accounts of regular customers for a sum of $2,500.

(d) The auditor knew the “regular” credit customers (Jones, Blake, and Sellers) and doubted that any of them would default on a debt.

The sequence of events appears to have been:

a. At completion of the job, $2,500 was collected in cash from the new customer and pocketed by the clerk-bookkeeper.

b. To cover the theft, and yet provide a record of the transaction, a fictitious account receivable was debited for the $2,500, instead of Cash.

c. When the three regular customers paid their accounts, Cash was debited for a total of $2,500 and the fictitious account receivable credited for the same amount. The regular customers' accounts were credited as bad debts so that they would not be billed nor have reason to call attention to incorrect balances. All the bookkeeper had to do was find one account, or a combination of account balances, to write off a total of $2,500. This was done: $800 + $750 + $950 = $2,500.

The outside CPA has a professional responsibility to report these concerns and findings to the owner.

Req. 2--Recommendations:

(a) Report the circumstances to the owner. Do not recommend a change in the clerk-bookkeeper; the owner must make the personnel decisions involved.


CP6–6. (continued)

(b) Recommendations on internal control measures:(1) Separate cash-handling function from the related recordkeeping function.(2) Establish a definite routine for handling cash receipts.(3) Deposit all cash receipts intact each day.(4) Make all payments (except for cash on hand payments) by check. Do not

sign checks in advance. Require that supporting documents be attached to each check before signing. Designate all such documents as PAID when the check is signed.

(5) Establish a cash on hand fund. For control assign it to one person who is not involved in recordkeeping.

(6) Exercise strict control of write-offs of uncollectible accounts.(7) Continue the annual audit.

CP6–7.

1. No, because the service is completed over a short time period and the difference in sales for that period from year to year is not large.

2. $365,000,000 under each. For the fiscal year 2004, UPS recognizes revenues from December 31, 2003 to December 30, 2004 pickups (365 days). Federal Express recognizes revenues from January 1, 2004 through December 30 pickups plus half of December 31, 2003 and December 31, 2004 pickups. Airborne recognizes revenues from January 1 through December 31, 2004 pickups.

3. If there was a significant increase or decrease in pickups from year to year, the different methods could cause different amounts of revenue to be recognized in each period, though the total revenues over the life of the company would still remain the same.

4. Either the UPS or Federal Express rule is more correct conceptually (follow the revenue recognition rules). However, since the choice does not materially affect the financial statements, we have no preference among the three.


CP6–8.

1. Backdating sales orders and recording sales for goods or services that had not been shipped or delivered as of year-end violates the revenue principle. (Note that recording sales revenue "for fees that had not yet been received" is not a violation of the revenue principle.) Recording revenue for sales that were subject to cancellation, without estimating returns properly, is also a violation.

2. If the Company recognized revenue on such contracts, it should establish a sales returns and allowances account (a contra revenue) for potential cancellations. An estimate of future cancellations should be made and the amount should reduce net sales in the period the revenue is recognized.

3. Profiting from sales of stock they owned at an inflated stock price and receiving bonuses determined on the basis of growth in net income probably motivated management. Management was very focused on reporting increased growth because the growth fueled the run-up in the stock price.

4. The other investors who paid inflated amounts for the stock, customers who were poorly served during the period, and employees of the company who were drawn into the fraud and suffered damage to their reputations were all hurt by management’s conduct.

5. Sales transactions booked near the end of the quarter and sales with special terms, e.g. right of return or cancellation, should receive special attention from auditors.

FINANCIAL REPORTING AND ANALYSIS PROJECTS

CP6–9.

The solutions to this case will depend on the company and/or accounting period selected for analysis.


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